Will competition change the water industry?

Last month, Sonia Brown, Senior Director of Markets and
Economics at Ofwat, delivered an interesting lecture on overcoming barriers to
competition in water, as part of the Beesley Lecture series. Sonia’s lecture focused on the rationale for
applying market forces to deliver goals of greater choice for customers and
greater productive, dynamic and allocative efficiency within the industry.

The water sector is about to enter a period of change,
including the introduction of greater competition. The UK Government published a draft Water
Bill in July 2012, expanding the market reform proposals and commitments made
in the Water White Paper issued in December 2011. The key initial milestone for market reform
is the target date of April 2017 for opening a cross-border retail market
between England and Scotland. Meanwhile,
Ofwat has started the consultation process on the price limits for the next
regulatory period (2015–20) including separate wholesale and retail price
limits, as well as extending accounting separation to measure the costs of
services provided by the water companies.
The proposed reforms have led to regulatory uncertainty while the
details of implementation are worked through.

While the reforms could lead to a tougher operating
environment, they could also offer new opportunities for the more efficiently
run water companies. The changes are the most extensive and
far-reaching since privatisation in 1989, - though the core regulatory
framework will remain in place for wholesale (core infrastructure) operations.

The market
reforms broadly fall into three areas:

Extending the retail market to all non-domestic
water and sewerage customers in England and steps towards a cross-border market
with Scotland (currently the market is only open to customers using over 5
million litres per year).

Increased water and (potentially) wastewater
trading between companies, aimed at achieving a more efficient allocation of
resources between companies.

Allowing entry to the market for upstream
resources and treatment. However, the design of upstream market arrangements is
likely to be complex, and significant work from government, regulators and the
industry will be needed to implement them, with uncertain outcomes.

More information on the reform of the water sector is
available on our website www.pwc.co.uk/water.

Sonia Brown argued that business customers want greater
choice, and that companies are already reacting to the future changes to the
retail market proposed in the draft Water Bill.
Examples include companies in England obtaining licences in the existing
market for non-domestic water and sewerage retail in Scotland; and incumbents
restructuring their retail and wholesale functions to improve the emphasis on
service to customers. This may be an
early indication that the reforms proposed in the draft Water Bill will drive
innovation.

She also highlighted dissatisfaction among individual
domestic customers who appealed complaints to Ofwat. However, the White Paper effectively rules
out domestic competition. So domestic
water customers will remain reliant on the regulator to drive improvements in
efficiency and service.

The overall structure of the incumbent companies is left
unchanged by the draft Water Bill, which retains the vertically integrated
‘source to tap’ and ‘sink to sea’ model for incumbent licensing and
regulation. This follows the
Government’s direction, set out in the White Paper, that the investment model
for the industry should be protected to ensure that incumbent companies can
deliver significant future infrastructure needs efficiently. Sonia expressed a strong view that allowing
exit from the retail business for incumbent companies on a voluntary basis
would be beneficial and should be allowed.
The industry broadly agrees.

Sonia Brown pointed out that the continued vertically
integrated structure of the incumbent companies is likely to result in the need
for additional safeguards to achieve a ‘level playing field’ for entrants and
incumbents. Various policy levers are
available, including the licence and market rules contained within the
statutory market codes that will be part of the reforms. But licence changes could involve significant
compliance costs or risks for incumbent companies. The industry will be keen to understand the
changes Ofwat will be proposing to achieve a level playing field due to the
significant impact it is likely to have on the way they operate their
businesses, and manage staff conduct.

While the draft Water Bill sets out a clear Government
direction on retail and upstream competition, delivering the reforms is a major
challenge for the industry. The Bill leaves many areas of uncertainty,
including market design, access pricing, and the detailed contents of statutory
codes - so the devil will be very much be in the detail of how these are implemented. The industry will be heavily involved in
developing solutions through the High Level Group and working groups tasked
with implementing the reforms, which should allow companies to raise their
concerns, and hopefully provide an open forum to offer practical solutions.

Sonia Brown argued that market forces are a more effective
tool than regulation in resolving issues such as arriving at the best means of
allocating scarce water resources, especially in the south and east of England
where there are areas of overabstraction or overlicensing of water
sources. There is debate within the
industry whether the combination of abstraction-related incentives and use of
market forces is sufficient to replace the sort of co-ordinated approach to
managing water resources that has historically been undertaken by companies
during droughts. Comparisons with
energy, where long term security of supply is a key issue for Government, would
suggest that these concerns warrant closer consideration during the implementation
process.

In the latter part of the lecture, Sonia highlighted
enabling reforms that will underpin future regulation, including separation of
retail and wholesale price limits and the introduction of a new incentives
framework for the sector. Taken as a
whole, the reforms are the largest collective set of changes to occur in the
England and Wales water and sewerage sector since privatisation in 1989. The water sector needs to make itself ready
for the significant tasks that will be asked of it over the coming years.

Post your comment

Comments are moderated, and will not appear until the author has approved them.

We welcome your comments or feedback on this article. You can leave your comment in the box below - your personal details are not published with the comment. If you have a TypeKey or TypePad account (optional), please
Sign In